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The Ultimate Guide to Walter Schloss Investing cover

The Ultimate Guide to Walter Schloss Investing

When you think of investing, the first name that comes to your mind is Warren Buffet- and with good reason. Buffet has a legendary track record and has generated very high returns for his investors since the ’60s. But a lesser-known investor who was just as good and referred to as ‘Big Walt’ by Buffet is Walter Schloss, one of the most legendary investors in the investment world.

Background

Walter Schloss’ investment theories are most applicable to small value investors and were based on the teachings of Benjamin Graham (another icon in the investing world and also known as the father of the value investing).

Schloss’s studies helped gain an insight into how to perform deep value investing that is still relevant in today’s market. While the basis of Walter Schloss’s principles were based on Graham, he developed his own strategies while staying close to the fundamentals. His theories earned him the title ‘Superinvestor’ in 1984.

The Investing Playbook

Walter Schloss’ investment strategies involved a more ‘play by the book’ approach of investing in undervalued stocks. He focused on the quantitative factor and instead of following every stock he owned, Schloss decided to follow stocks based on valuation and buying at a discount to the intrinsic value. In 1994 Schloss listed the factors he believed were required to make money on the stock market. I have discussed the most important factors below:

1. Price is the most important thing when it comes to buying stocks

Walter Schloss’ believed Ben Graham’s philosophy that ‘a stock well bought is half sold’. He felt that every stock will become an attractive buy at a certain point as long as the price dropped low enough to provide a safety margin.

2. The price of a stock in relation to its book value is the most important factor in valuing stocks

Walter Schloss never bought stocks that had a premium to book value ratio. Instead, he bought it at a discount to book value as it provided a margin of safety. The investors who remained patient in the short run would be rewarded in the long run if they systematically bought discounted stocks.

3. Buy stock in companies that have been in business for a while

Schloss preferred to invest in stocks of companies that have a long history of being in business. The fact that these businesses have been in operation for so long gives the investor the confidence that the company will continue to operate long into the future as well. It can also help identify their business cycle and compare the book value earnings. Walter Schloss’s also invested in companies that were going through a downturn in their business cycle if he believed that the asset portfolio was strong and the chances of the company performing well in the long-term seemed favorable.

4. Maintain a diverse asset portfolio and stay fully invested

Walter Schloss usually traded a 100 different stocks at any given time and he was a 100% invested. During a high market valuation, he would adjust his price to book value upward if the company was paying a good dividend. But he relied on dividends rather than earnings as an indicator of a company’s profitability.

When analyzing the quality of the management in the company you choose to invest in, Walter Schloss believed that being ethical was more important than just being smart. In an interview, he said: “In a choice between a smart guy with a bad reputation and a dumb guy, I think I’d go with the dumb guy who’s honest. Of course, you can’t always protect yourself there, either. I guess the choices we’ve made are probably in those areas.”

The ‘rules of investing’ were written by Walter Schloss many years ago but they still remain relevant today. If an investor learns to stick to a small value approach, it will benefit them in the long run. Keep it simple.

Also read: Why Warren Buffet Suggests- ‘Price Is What You Pay, Value Is What You Get’?

Walter Schloss and Portfolio Management

Walter Schloss did not invest too much time assessing the details of a particular stock to the very last detail rather he studied the company financials and did not overanalyze each investment opportunity. He spread his risks evenly and sometimes invested just $10,000 in a stock. His portfolio consisted of a hundred stocks.

In the initial investment, Schloss would take a small position and eventually buy more if the difference between the trading price and intrinsic value continued to widen. In particular, he preferred to invest in companies with a higher margin of safety and focused on stocks with low leverage.

Walter Schloss’s deep value investing

As a small value investor, the strategies used by Walter Schloss are extremely relevant. Walter Schloss’s investment strategy was incredibly old-school, he was a simple man and operated more like a small-time investor rather than a professional financial advisor. Schloss never aimed to reach new heights as an investor and continued to use and search for new deep value investing ideas till the very end.

Value investing are stocks that trade lower than their book value and while it is hard to find these stocks in today’s market where ‘money never sleeps’, this old school strategy developed by Walter Schloss is still important. Here are the key takeaways of this investing style:

  • The main criteria of the investor should be to discount your stock to a tangible book value
  • The quality of the management is also important, if the company is not confident in their management, then neither should you
  • Having a diversified portfolio is incredibly important. In the long term, it is the valuation of your portfolio that helps you earn large gains in the stock market.

Also read: #5 Things Warren Buffett looks for before investing.

BONUS: 16 Investing Rules from Walter Schloss

(FROM A 1994 LECTURE)

  1. Price is the most important factor to use in relation to value.
  2. Try to establish the value of the company. Remember that a share of stock represents a part of a business and is not just a piece of paper.
  3. Use book value as a starting point to try and establish the value of the enterprise. Be sure that debt does not equal 100% of the equity. (Capital and surplus for the common stock).
  4. Have patience. Stocks don’t go up immediately.
  5. Don’t buy on tips or for a quick move. Let the professionals do that if they can. Don’t sell on bad news.
  6. Don’t be afraid to be a loner but be sure that you are correct in your judgment. You can’t be 100% certain but try to look for the weaknesses in your thinking. Buy on a scale down and sell on a scale up.
  7. Have the courage of your convictions once you have made a decision.
  8. Have a philosophy of investment and try to follow it. The above is a way that I’ve found successful.
  9. Don’t be in too much of a hurry to see. If the stock reaches a price that you think is a fair one, then you can sell but often because a stock goes up say 50%, people say sell it and button up your profit. Before selling try to re-evaluate the company again and see where the stock sells in relation to its book value. Be aware of the level of the stock market. Are yields low and P-E ratios high? If the stock market historically high. Are people very optimistic etc?
  10. When buying a stock, I find it helpful to buy near the low of the past few years. A stock may go as high as 125 and then decline to 60 and you think it attractive. 3 years before the stock sold at 20 which shows that there is some vulnerability in it.
  11. Try to buy assets at a discount than to buy earnings. Earning can change dramatically in a short time. Usually, assets change slowly. One has to know much more about a company if one buys earnings.
  12. Listen to suggestions from people you respect. This doesn’t mean you have to accept them. Remember it’s your money and generally, it is harder to keep money than to make it. Once you lose a lot of money, it is hard to make it back.
  13. Try not to let your emotions affect your judgment. Fear and greed are probably the worst emotions to have in connection with the purchase and sale of stocks.
  14. Remember the work compounding. For example, if you can make 12% a year and reinvest the money back, you will double your money in 6 yrs, taxes excluded. Remember the rule of 72. Your rate of return into 72 will tell you the number of years to double your money.
  15. Prefer stock over bonds. Bonds will limit your gains and inflation will reduce your purchasing power.
  16. Be careful of leverage. It can go against you.

Conclusion

The Walter Schloss investing style is great for anyone looking to invest in small companies. The strategies help reduce risk with the promise of high returns.

Unlike Warren Buffet’s investing style which requires the ability to identify a competitive advantage and do thorough research into a company’s financial statements that most people don’t have the know-how to do. Schloss provides a great alternative to this- focus on assets rather than earnings.

Many small investors are in the habit of solely investing in a company based on its annual earnings but they are more likely to succeed if they focus on the assets in the balance sheet. Walter Schloss investing is a time-tested lesson that still holds true today.

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The Stock Market Cycle: 4 Stages That Every Trader Should Know!

From the changing seasons to the different stages of our lives, cycles exist all around us. These cycles are often influenced by numerous factors at each stage. Likewise, cycles also affect the movements of stocks in the market. Understanding how these movements work can help a trader identify new trading opportunities and lower their risk.

In this post, we are going to discuss the four stock market cycle stages that every trader should know. Let’s get started.

Stages in the Stock Market Cycle

The movement of prices in the stock market can often seem random and hard to follow. Prices may go up on certain days, and down on others. To an average person, these shifts are often confusing and the prices can resemble a casino game.

The reality, however, is that the stock market cycles move in similar ways and go through the same phases. Once an investor understands the phases, the markets will not seem so random anymore. The trader can recognize each phase and change their style of trading accordingly. There are four phases in the stock market cycle as follows:

four stages of stock market cycle

(Image Credits: Investopedia)

1. The Accumulation Phase

accumulation phase

(Image credits: Investopedia)

This phase of the stock market can apply to an individual stock or the market as a whole. As the name suggests this phase does not have a clear trend and is a period of agglomeration. The stock tends to trends at a range as traders accumulate their shares before the market ‘breaks out’. It is also known as the basing period because the accumulation phase comes after a downward trend but precedes an uptrend.

The moving average does not provide a clear indicator at this point as the market is not following a particular trend. The longer the accumulation phase the stronger the break out in the market when the stocks start to trend.

How to trade:

The accumulation phase may last a few weeks or a few months. So use this time to study the market and anticipate the right time to enter. The price range during this period is small and not particularly advantageous for day traders. It is advisable not to make large trades at this time until a market trend is confirmed. A current event in the economy can take stock out of this phase as you begin to see an uptrend. Once this accumulation phase is broken, you begin to see highs and lows in the market as we move on to the run-up phase of the market.

2. The Run-Up Phase

Just as the accumulation phase is defined by its resistance to the changes in stock prices, the run-up phase is defined by the price going above this resistance level. The breakout of the accumulation phase results in a high volume of shares as the traders who remained silent during the accumulation phase aggressively purchase stocks. As this period progresses we begin to see a trend in the prices. The highs and lows in the market attract more traders as they begin investing. This result in an upward trend as the market becomes stronger and moves on to the next phase.

How to trade:

This is the best time for a trader to make money. There is a lot of upward movement of prices which is great for momentum traders. Any downward trend during this period is not viewed as a bad thing but rather an opportunity to buy shares. When the market goes down, the shares will get bought up as the market begins to trend again. The run-up phase is best for swing or short-term traders. As this phase progresses, the volatility in the market decreases as prices move slowly every day.

3. Distribution Phase

distribution phase

(Image Credits: Investopedia)

This phase, also known as the reversal stage, is when traders who purchased stocks during the accumulation phase begin to exit the market. A prominent feature of this phase is an increase in the volume of shares but not in its price. The market is usually bullish but the demand does not exceed the supply of shares enough for the prices to increase. There are usually hard sell-offs but not enough to make the market trend downward.

How to trade:

There is a lot of volatility in the early stages as investors begin to pull out of the market which presents a good shorting opportunity as the market reaches the bottom it will bounce back with velocity. The distribution phase is identified through certain chart patterns like the head-and-shoulders top or bottom top. As the phase progresses the market starts to lose its volatility as a range begins to form. This is not the best situation for momentum traders.

4. Decline or Run-down Phasemark down cycle

(Image Credits: Investopedia)

This is the last stage of the stock market cycle and is not a favorable time for most investors. Those traders who bought stocks during the distribution phase hastily try to sell as they are underwater on their positions. However, there are few buyers to meet the sale of shares. This lack of demand drives down the prices of stocks. If there are higher lows in the market for a long period of time, it signifies that the market is headed towards the accumulation stage.

How to trade:

During this phase prices of stocks fall lower than expected so ‘don’t try to catch the falling knife’. A bear marker provides a good opportunity for long trades if the right strategies are used. It is important not to panic and sell during this period because these phases don’t last forever.

Also read:

Conclusion:

Understanding each of the phases in the stock market cycle is essential to making the right decisions when it comes to buying and selling stock. A good way to study these phases it to study the past chart trends of particular stocks. You can identify certain indicators at each phase. Finally, always remember this quote by Yvan Byeajee- “Trading effectively is about assessing probabilities, not certainties.”

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How do oil prices affect the stock market?

Crude oil is considered to be one of the most important commodities in the global economy. It is versatile in its uses and helps industrialize economies. A variety of things from plastics to rubber and machinery uses crude oil or its byproduct, making it a crucial element in the raw materials for many businesses in the economy.

Hence it is no surprise that the stock market is often influenced by the price of oil. It can affect an individual investor or have a domino effect on the stock market. Here are some of the ways oil prices affect the stock market:

How do oil prices affect the stock market?

– Profitability of oil companies

The oil business has two main components to it, the upstream and downstream business.

The upstream business is involved in the drilling of oil wells and the manufacture of crude oil in industries. Examples of such businesses include Oil India and Shell.  When these companies are profitable it usually results in high stock market prices because the crude oil manufactured by these companies is the raw material for many businesses.

If upstream companies find it hard to drill for oil and face an increase in research and development costs, it could have an adverse effect on the value of the oil company’s stock.

The second type of oil business is the downstream business. These are corporations involved in the distribution and retail function of crude oil. They are in control of your local gas stations such as Indian Oil and Bharat Petroleum. These companies find low crude oil prices beneficial as they can now purchase crude oil at a low price from upstream companies.

– Consumer Demand

Almost everything that a person consumes is tied to oil such as electricity or fuel for their cars.

An increase in the price of oil can raise the daily living costs for people, reducing the amount of money they have available to spend on other goods and services such as electronics or clothing. The revenue of these companies decreases as consumer demand for their goods and services falls. The negative effect on the earning of firms lowers the value of their stock.

Alternatively, a decrease in oil prices has the opposite effect. When consumers spend less on fuel, it gives them more money for other goods and services. The increase in demand raises earnings and has a positive impact on the stock market.

How do oil prices affect the stock market cover

– Profitability of other industries

Since all businesses use a byproduct of oil, an increase or decrease in the price of oil can indirectly affect them as well.

If the price of oil increases, a delivery services company will face higher fuel costs. These costs will be translated to consumers as high prices for their services. The low earnings of the company will result in low stock prices for the industry.

Likewise, if oil prices decrease, the companies can charge lower prices to consumers and have high profitability and higher share prices. In reality, however, companies rarely lower the prices of goods and services if the price of raw materials has decreased.

– Impact on Inflation

The price of oil can directly or indirectly increase or decrease costs of goods and services in the economy and can result in inflation. In the United States, the price of oil is not considered a factor when the inflationary rate is calculated but its price can cause a ripple effect in the economy through industries that use crude oil as a raw material.

If oil prices rise, it can increase the cost of living for individuals, putting a pressure on wage rates to make up for this. The high labor costs increase the costs of goods and services and increase the rate of inflation in the economy as each dollar can now buy fewer goods and services. When inflation rises the stock prices of the industry decline.

Also read:

– Effect on Imports

For countries such as India that import almost 80 percent of its crude oil, a decrease in the price of oil is beneficial because it decreases imports expenditure and stabilizes the exchange rate of the currency.

However, a reduction in oil prices isn’t always great for the stock market. There is a positive relationship between the Foreign Direct Investment and the price of oil. When the price of oil goes up, oil-rich countries invest in emerging oil markets like India. However, when prices go down, they withdraw their investments.

Hence with a fall in oil prices, few foreign investors will invest their money in the Indian stock markets resulting in a negative impact on stock prices.

Conclusion

The versatility of the crude oil has made it an influential factor in the increase and decrease of stock prices. The price of oil not only affects the stock of oil companies but also the stocks of industries that use it a byproduct of it.

While the exact amount of influence it has on stock prices cannot be calculated, the price of this commodity can increase or decrease the total costs of production of many goods and services. This can affect the amount of goods people consume to exchange rate and the level of foreign direct investment which collectively affect the stock prices in an economy.

Needless to say, the price of crude oil has the ability to affect the level of investment in the economy and influence stock prices.

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6 things you should NOT do when the stock market is Volatile!

Investing in the stock market is known to provide some of the highest long-term returns and can earn investors a profit in manifolds over the years.

People invest in stocks to reach their financial goals and earn a profit on their savings. It is a way to make money work for you rather than you working for the money.

What is stock market volatility?

Investing in stocks is a risky business. While investors can earn a high return on shares, we cannot overlook the volatility that comes with it.

Volatility can be described as the continuous change in the prices of stocks over a short period of time. Here, the price of stocks can rise on a certain day and can fall the very next day. For example, you may have seen situations where Sensex may have fallen over 400 points in a day and recovered on the very next. This can be considered as volatility.

High volatility also increases the VIX ratio (Volatility Index) also known as the Fear Index. It measures the amount of fear in the market as a result of the volatility.

The fear caused by a volatile market makes investors react in many different ways. Some start to panic as their investments get riskier and try to sell & exit the market. On the other hand, there are contrarian investors, who prefer investing only in situations when others are selling. Anyways, as shares start to lose value, investors often make hasty decisions that can result in terrible outcomes.

6 things you should NOT do when the stock market is volatile!

Here are six things investors should not do when the stock market is volatile:

1. Don’t Panic!

The number one reaction investors have when there is volatility in the market is to panic and make speculations. It is important not to be influenced by fear and do something irrational. Investors can consider buying a stock at a lower price but should not panic-sell. Instead, they should use this period of volatility to evaluate the stocks in their portfolio.

There are often many reasons why a person invests in a particular stock in the first place. If the fundamental values of why you invested in the stock are clear, then you should remain invested. However, if you are not sure of a particular investment, meet with your financial planner to decide a course of action to exit the market.

Remember, volatility in the market is only short-term, don’t panic-sell if your long-term objectives of investing in the market haven’t changed.

panic selling

2. Don’t buy JUST BECAUSE prices are low!

When there is volatility in the stock market it is not advisable to invest in the market just because prices are low. This is because there is no guarantee that a stock with a low price today will increase in value in the future. In fact, the price may go even lower and you could end up in a value trap. (Also read- What are value traps?)

You need to analyze the stock’s fundamentals and track record. Look into factors like revenue growth, profit margin, price to earnings, debt-to-equity ratio etc as well as its future potential. If the stock shows a history of riskiness and volatility it would be best not to invest in them. Don’t be a bottom fisher!

3. Don’t believe everything you see on the news!

A sudden ‘breaking news’ segment on the stock market can cause people to make investment decisions that can prove to be disastrous in the future. News reports are not always authentic and often mislead or misguide the investor which can affect the sustainability of a stock.

News reports about the volatility of stock markets are usually short-lived and stock prices will bounce back like a ping-pong ball before you know it. This short-term volatility is often due to a current event in the economy. Once the event has passed, your stock price should be back to normal. As a serious investor, be aware of ‘breaking news’ but don’t follow it blindly.

news

4. Don’t make decisions based on international markets!

During certain periods, there can be a correlation between local and international stock markets. For example, a change in the leadership of a country could affect numerous economies around the world. But statistically speaking, such a correlation does not exist most of the time.

Volatility in the stock market is a reflection of individual events in an economy or movements in the economic cycle. The stock prices are a result of the anatomy of the local economy. For example, the Dow Jones in the US is completely independent of the stock prices in NSE’s NIFTY. Hence, investors should not be influenced by volatility in international markets, there may be various factors that could affect these stock prices.

5. Don’t rush to invest in volatile sectors!

An important rule for investors is to study trends in the market before investing. If there are particular stocks that drive bear markets- avoid these.

A stock that has a financial risk and a low standard of corporate regulations often lead to long-term problems and has a low chance of recovering. These stocks will have short bursts of upward movements but will have a long-term downward trend.

Do a market analysis of the sector you are investing in, if the industry shows a history of high volatility- you should remain of cautious before you invest too much money into it.

6. Don’t put all your eggs in one basket- Diversify your portfolio!

diversification do not put all your eggs in one basket

One of the biggest mistakes an investor can make is not investing in a variety of stocks. If a certain industry shows potential for high returns, it is not a wise decision to invest all your money here. This is because if a certain economic event has a negative impact on the industry- it could result in a huge financial loss for the investor.

It is better to spread your risk and invest in different stocks that are stable, have a strong market presence and good growth potential. Here, even if you face volatility in one of your assets, you have a diverse portfolio of stocks to cover your losses.

An investor looking to reduce their risks and control losses should diversify their portfolio and not invest in too many volatile stocks. Greed can often take over fear and this can prove to be disastrous. Investors need to perform a thorough analysis of the stock market before picking stocks to invest in. If they do not have the bandwidth to do this, they can consult a financial advisor.

Also read:

Follow the tips listed above to help you get through a period of high stock market volatility. While it is important to safeguard your portfolio from the effects of a volatile market, remember the biggest risk is not taking any risk at all.

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How Does The Stock Market Affect The Economy?

A stock is a type of security that represents an individual’s ownership in a company and a stock market is a place where an investor can buy and sell ownership of such assets.

Trading stock on a public exchange is essential for economic growth as it allows companies to raise capital through public funding, pay off debts or expand the business.

Why do we have a stock market?

The stock market exists for two main reasons, the first is to provide a company with the opportunity to raise capital that can be used to expand and grow the business.

If a company issues one million shares that can sell at $4 a share, this allows them to raise $4 million for the business. Companies find it favorable to raise capital this way so they can avoid incurring debt and paying steep interest charges.

The stock market also provides investors with the opportunity to earn a share in the company’s profit.

One way to do this is to buy stocks and earn regular dividends on its value- that is the investor earns a certain amount of money for each stock they own.

Another way is to sell the stock to buyers for a profit when the price of the stock increases. If an investor buys a share for $20 and the price eventually increases to $25, the investor can sell the stock and realize a profit of 25%.

Also read: Why do Stock Markets Exist? And Why is it So Important?

How the Stock Market affects the Economy?

The increase and decrease in stock prices can influence numerous factors in the economy such as consumer and business confidence which can, in turn, have a positive or negative impact on the economy as a whole. Alternatively, different economic conditions can affect the stock market as well.

Here are a few ways the stock market can affect the economy of a country:

Movements in the Stock Market

The movements in the individual prices of stocks give the stock market a volatile character. As stock prices move up or down, their volatility can have a positive or negative impact on consumers and businesses.

In the event of a bull market or a rise in the prices of stocks, the overall confidence in the economy increases. People’s spending also increases as they become more optimistic about the market. More investors also enter the market and this feeds into greater economic development in the nation.

When the prices of stock fall for a continuously longer period, also known as a bear market, it has a negative effect on the economy. People are pessimistic about the economic conditions and news reports on falling stock prices can often create a sense of panic. Fewer investors enter the market and people tend to invest in lower-risk assets which further depresses the state of the economy.

Also read: What is Bull and Bear market? Stock Market Basics

bull and bear market

(Image credits: 5paisa.com)

Consumption and the Wealth effect

When stock prices rise and there is a bull market, people are more confident in the market conditions, and their investment increases. They tend to spend more on expensive items such as houses and cars. This is also known as the wealth effect which is how a change in a person’s income affects their spending habits and eventually leads to growth in the economy.

In the case of a bear market or a fall in stock prices, there is a negative wealth effect. It creates an environment of uncertainty among consumers and a fall in the value of their investment portfolios decreases spending on goods and services. This affects economic growth as consumer spending is a major component of Gross Domestic Product.

A common situation of the wealth effect was during the US housing market crash of 2008, which had a large negative impact on consumers wealth.

what's the economy

(Image credits: Investopedia)

Impact on Business Investment

Apart from consumer spending, business investment is also a key indicator of economic growth.

When stock prices are high, businesses are likely to make more capital investments due to high market values. Many companies issue an IPO during this time as market optimism is high and it is a good time to raise capital through the sale of shares. There is also more mergers and acquisitions during a bull market and firms can use the value of their stock to buy out other companies. This increased investment feeds into greater economic growth.

When the stock market is bearish, it has the opposite effect on investment. Confidence in the economy decreases and businesses are no longer eager to invest in the economy. The decrease in share price makes it harder for companies to raise funding in the stock market.

Other factors

The stock market also affects the bond market and pension funds. A large part of pension funds are invested in the stock market and a decrease in the price of shares will lower the value of the fund and affect future pension payments. This can lower economic growth as people who depend on pension income will tend to save more and this lowers spending and eventually the GDP.

While a fall in share prices has a negative impact on economic growth and GDP of a nation, it has a positive effect on the bond market. When there is a depression in the stock market, people look for other assets to invest their money in such as bonds or gold. They often provide a better return on investment than shares in the stock market.

Remember, it is always important to diversify your investment portfolio and spread your risk. Don’t throw all your eggs into one basket.

The stock market and the economy are not the same

Contrary to popular belief, the stock market and the economy are two different things. The GDP of an economy and the stock market gains are incompatible and, in fact, there is little comparison between the two. The major reason for this discrepancy is the difference in the size of the two markets. The economy depends on millions of factors that can have both a positive and negative impact, while the stock market is only affected by one factor, the supply and demand of stocks.

Also read:

For investors in the stock market, it is better to err on the side of caution and focus on the fundamentals of each stock rather than on the economy as a whole. As the saying goes ‘an economist is a trained professional paid to guess wrong about the economy’.

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Why do Stock Markets Exist? And Why is it So Important?

A stock market is a public market where people can buy and sell shares on the stock exchange. The stocks, also known as equities, represent ownership in the company.

Stock markets have existed for centuries. The oldest stock exchange was started in Belgium back in 1531. The brokers and moneylenders used to meet there to deal with the businesses. However, they never used actual stocks but traded in promissory notes and bonds. Later, the Amsterdam Stock Exchange was established in 1602 by the Dutch East India Company and regarded as the first real stock exchange.

Since its inception, stock markets have served many purposes, the most important being to provide companies with a source to raise capital for investment and expansion.

Why do stock markets exist?

Stock markets exist to serve the wider economy. It helps individuals earn a profit on their income when they invest in the stock market and allows firms to spread their risks and receive large rewards. It also enables the government to increase spending through the tax revenue they earn from corporations that trade on the stock exchange. The government uses the revenue to increase re-investment and employment capacity.

The stock market plays an important role in the economy of a country in terms of spending and investment. Without stock markets, many countries would not be as developed as they are. Alongside, it has helped individuals become wealthy and increases the overall standard of living in many economies.

Following are some of the most important functions of a stock market in the economy:

It helps companies raise capital

If stock markets did not exist, companies would have to resort to borrowing from the bank to raise money for expansion. This would be a burden on the company as they would have to repay the loans with interest.

Fortunately, with stock markets, businesses have the ability to create an initial public offering and raise large amounts of cash without having to worry about repayment. Moreover, publicly traded companies have no obligation to pay dividends when they incur losses.

Capital raised this way can help companies expand operations and create jobs in the economy. From a greater economic perspective, consumer spending increases,  governments can benefit from tax revenues and there will be lower levels of unemployment.

It helps create personal wealth

One of the most important benefits of the stock market is its ability to help generate personal wealth in the economy.

For the individual investor, the stock market provides a way to invest your income to earn a share of the companies’ profits. The revenue they earn can increase spending in the economy that can have a multiplier effect. The increased spending by individuals leads to increased investment and employment.

It helps increase investment in the economy

One of the key drivers of Gross Domestic Product is the level of investment in the economy. Governments often create fiscal and monetary policies in the economy to promote greater investment. The stock market is considered to be one of the most prominent sources for people to invest money in.

Furthermore, investors are always looking to invest in companies with high growth potential. If the stock market is performing well, this not only increases investment from local investors but also attracts foreign direct investment as people abroad invest in the local stock exchange. For example, people in India can invest in the NYSE which helps increase GDP of the US economy or vice-versa.

It serves as an indicator of the state of the economy

sensex last 30 years

(Sensex last +30 years graph)

The performance of the stock market is a rough indicator of how well the economy is performing. This often depends on speculators and perceptions of investors in the market. A rise or fall in the price of shares represents what cycle the economy is in such as recession or a boom.

There is a symbiotic relationship between the state of the economy and the performance of the stock market. Economists use this as a way to analyze past performance of investment and spending which helps them in the creation of new economic policies. The stock market serves as a barometer for the economy.

Also read:

It also affects non-investors in the economy

All members of society are affected by the stock market performance regardless of whether or not they invest in stocks.

People with pension funds and retirement accounts are impacted by low stock prices as the value of their accounts is tied to the stock market. Companies can also reduce employee benefits (pensions) as they can no longer afford to spend money on this which can delay the retirement age. Furthermore, when a company’s share price goes down, it affects job security as firms cut back on spending and many people could end up losing their jobs.

The stock market also impacts the rate of taxes and interest rates set by the government. During the Great Depression, the US government lowered taxes to induce borrowing but once the economy was out of depression, the government increased interest rates to encourage investment. Interest rates can affect a non-investor because a person renting out a home does not have to pay interest on a home loan directly but the landlord is likely to increase the rent to cover the high-interest expense.

Closing Thoughts:

Stock market gives opportunities to the businesses and public to transfer capital and ownership in a controlled, secure and managed environment. In addition to providing a convenient way for companies to raise capital and for individuals to increase wealth, the stock market helps keep a check on corporate regulation and increases the economic growth and prosperity of the nation.

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Socially Responsible Investing: Why it matters?

Deciding how you want to invest your money is often hard. You need to take many factors into consideration such as risk, returns, taxes, and inflation. It takes a lot of forethought and groundwork to figure out a way to get the best return on your investments.

Yet, there are some investors who choose to invest in companies that are not only financially stable but also make a positive impact on the environment.  Socially Responsible Investing or SRI is choosing to invest in stocks that provide a financial gain as well as do social good.

The companies are evaluated based on the ESG index: environment, social justice, and corporate governance.

Although socially-responsible investing is still up and coming in India, it is expected to gain greater momentum in the next few years. Companies have become more aware of the ESG factors and are looking to incorporate more of it into their business practices.

Socially Responsible Investing History

Socially responsible investing began in the early 1700s when the Quakers refused to participate in the slave trade in the U.S. Pastor John Wesley, the leader of the Methodist church claimed it was a sin to make a profit at the cost of your neighbor’s well-being. He stated that it was unethical to gamble and invest in industries that used toxic chemicals.

For many decades after John Wesley’s speech, investors avoided industries such as tobacco and liquor referring to them as ‘sin industries’. This evolved in the 1960s when investors decided to invest their money in companies that promoted social causes such as women’s rights and civil liberty.

Socially responsible investing played a huge role in South Africa during the 1980s when investors began pulling out their money due to the apartheid or the segregation of races. SRI had a prominent role in helping bring an end to the apartheid in 1994.

Sustainability Indexes

If you look into the American and European nations, they already a family of indices evaluating the sustainability performance of thousands of companies trading publicly. The Dow Jones Sustainability Indices (DJSI) launched in 1999, are the longest-running global sustainability benchmarks worldwide. To be incorporated in the DJSI, companies are assessed and selected based on their long-term economic, social and environmental asset management plans.

For India, S&P BSE has three main indices that measure corporate sustainability: S&P BSE 100 ESG INDEX, S&P BSE GREENEX, and S&P BSE CARBONEX.

How to be a Socially Responsible Investor?

Here are a few points that can help you become a socially responsible investor:

–        Know the difference: The first and foremost important step to become a socially responsible investor is to know the difference between traditional and responsible investing. The difference might be in returns that you get from your investments. The returns from socially responsible investing may differ a little from the traditional one as you might be leaving behind a lot of high return investment options. However, always remember the reason why you have opted for this way of investing.

–        Do your research: This is where investors use negative and positive screening to shortlist investment options. In the negative screening, they avoid investing in companies that don’t relate to their social values. Many mutual funds that are socially responsible screen out tobacco and liquor companies. One type of negative screening is divestment, this is where investors take their money out of certain companies because they do not like their business practices or social values.

Along with screening out negative companies, it is also important for investors to choose companies that align with their values. These are companies that strive to bring change to a social aspect that the investor finds important along with their socially responsible business practices. This is also known as impact investing or incorporation of ESG.

–        Use your influence as a shareholder: Shareholders not only invest in companies that align with their values but they also use their position to influence the actions of the company in which they own stock. Investors do this by filing a shareholder resolution. This is a document outlining the shareholder’s suggestions for management on how to run the company in a more socially responsible way.

–        Invest in the community: This is where an investor invests in companies that have a positive impact on the community. This is usually done in low-income areas where the investment is used to provide loans to people and small-business owners who would otherwise have trouble getting approved for a loan. Community investments also support ‘green companies’ that have a large carbon footprint on the environment.

–        Lead by examples: Socially responsible investing is still in the early adoption phase. By making the right investment choices, you can make a real positive impact on the community- along with building wealth. Moreover, sooner or later, social conscious will become the selling point for global companies. And you, being a part of it, can lead the movement.

Socially responsible investing: Promoting health

Socially responsible investing: Cleaner Environment

How to get started with Socially Responsible Investing?

1. Decide what your social principles are-

Before you choose your stocks you need to decide what social goals you want to promote. You should focus on your values and what you want to achieve through your investments.

2. Decide what your financial goals are-

The next step is to decide what financial goals you want to achieve through your investment just as you would with any other investment. You need to decide how much return you need to meet your goals as well as how much risk you are willing to handle. SRI has been shown to provide comparable returns as a traditional stock would.

3. Choose the fund that meets your needs and goals-

Once you have decided what your social and financial goals are, the next step is to find the investment that’s right for you. The most common ESG funds in India include Tata Ethical Fund, Taurus Ethical Fund, and Reliance ETF Shariah BeES.

Social investing has also resulted in the success of micro-finance. This was created by social investors to create an impact on small businesses and has now become an industry worth over $8bn and is now a mainstream financial service.

Socially Responsible Investing cover

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Conclusion

Socially Responsible investing is becoming increasingly popular in India and there has been a visible shift in the market strategy adopted by many participants as they incorporate social, economic and governance (ESG) factors into their investment process. Stakeholders realize the importance of their role in financial markets to influence sustainable growth.

According to the Indian Impact Investors council ‘more than 30 impact funds have invested in social enterprises in India’. There has been $2billion investment in over 300 companies in India.

While socially responsible investing is still not as big as traditional investing in India, it is still a rapidly growing market. Social investing in India has helped provide basic needs such as housing and education to the poor. Many investors have now realized the power and influence they have to make a positive impact on society.